Class 4: Relative Cost Analysis and Focus Strategies

MG106 Strategic Management

José Ignacio González Rojas

London School of Economics and Political Science

June 27, 2025

Today’s Investigation 🔍

Four Questions to Explore

1️⃣ How and why has the express mail industry structure evolved?

2️⃣ How have the changes affected small competitors?

3️⃣ How has Airborne survived and prospered?

4️⃣ What are the sources of Airborne’s competitive advantage?

Framework: Five Forces + Business Model Analysis

Task: 15 minutes, discuss questions in teams 🕐

Go! Start with Industry Evolution 🚀

Focus on what’s changed over time

Question 1: Industry Evolution 📈

How Has Express Mail Changed?

From Startup to Consolidation

The Early Days (1970s) 🌅

  • FedEx: 186 packages first night
  • Simple hub operations
  • Manual sorting
  • Modest fixed costs
  • Many small players viable

The New Reality (1990s) 🏭

  • 5+ million packages daily
  • $860M automated hubs
  • $3B IT investments
  • National advertising wars
  • 3 players = 85% share

What drove this transformation?

The Escalation Dynamic 🚀

Why Did Fixed Costs Explode?

The vicious cycle of competition 🔄

The Price Tag of War 💸

Just How Big Are These Investments?

Hub automation: UPS Louisville → $860 million 🏭

Aircraft: One Boeing 767 → $90 million ✈️

IT catch-up: UPS (1990-95) → $3 billion 💻

Annual advertising: FedEx → $138 million/year 📺

Can small players afford ANY of this?

The Sutton Effect 📈

From Competition to Concentration

The Pattern 🔄

  1. Intense competition
  2. Escalating investments
  3. Higher sunk costs
  4. Small players exit
  5. Industry concentrates

The Result 📊

  • 1970s: Many players
  • 1997: Big 3 = 85% share
  • Small players: Dead or dying

Classic endogenous sunk costs

Key insight: Competition itself changed the industry structure 🎯

FedEx vs UPS: The Convergence

Two Giants, Two Different DNAs

FedEx (1973) 💜

  • Born in the air ✈️
  • “Absolutely, positively overnight”
  • Technology pioneer
  • Empowerment culture
  • Premium positioning

UPS (1907) 🤎

  • Ground up heritage 🚚
  • Efficiency obsession
  • Time-motion studies
  • Command & control
  • Cost leadership

But then came the “Parcel Wars”… ⚔️

The Race to Sameness 🏁

By 1997: Mirror Images

The Convergence:

  • Products: Both offer overnight, 2-day, same-day ✓
  • Technology: Both have tracking, IT, guarantees ✓
  • Customers: Both chase consumer + business ✓
  • Pricing: Both discount 50% off list! 💸

Only 2 differences remain:

Culture (history) + Ground network (UPS only) 🚚

Question 2: Impact on Small Players 💀

The Casualty List

How Have Changes Affected Small Competitors?

The Victims 📉

  • Emery/Purolator: Retreated to heavy cargo
  • BAX: Pushed to periphery
  • Roadway Global Air: Exit after $100Ms losses
  • Others: Marginal players at best

Operating margins? Single digits 😰

Why They Failed

  • Can’t match scale investments
  • Price pressure from giants
  • Service expectations rising
  • No defensible position

Small + Undifferentiated = Dead

Yet Airborne thrives with 16% share… HOW? 🤔

The Scale Disadvantage Visualized 📊

The Death Spiral ☠️

Unless you find a different way to compete…

Question 3: Airborne’s Survival 🛡️

How Has Airborne Prospered?

Despite Everything, They’re Thriving!

The Numbers 📈

  • 16% market share
  • Fastest growing for years
  • Stock price doubling
  • Profitable (finally!)

The Puzzle 🧩

How does a company 1/9th the size of FedEx survive when others died?

Let’s analyze their model…

Hint: It’s not about competing head-to-head 🎯

Airborne’s Customer Focus 🎯

The Power of Saying “No”

YES to ✅: Large volume • Predictable • Dense routes • B2B • Price-sensitive

NO to ❌: Residential • Seasonal • Rural • Consumer • “Absolutely positively”

Paradox: Targeting the MOST powerful buyers? 🤔

Answer: They can serve them differently

The Activity System Revolution 🔧

Every Choice Reinforces the Strategy

Activity FedEx/UPS Airborne
Aircraft New planes 💰 Used planes ✈️
Hub Automated 🤖 Manual sort 👷
Airport Pay landing fees Own airport
Delivery Employees 65% contractors
Marketing $138M ads Zero ads 📵
Service 10:30 AM Noon delivery 🕐

The System Logic 🔗

Why Airborne’s Choices Work Together

Each “cheap” choice enables the others:

  • Predictable volume → Manual sort works ✓

  • B2B focus → No consumer ads needed ✓

  • Dense routes → Contractors reliable ✓

Result: 30% by truck, 80% plane utilization 🎯

You can’t copy just one piece!

Quantifying the Advantage 💰

The 20% Cost Edge

FedEx: $8.55/letter → Price: $9.00

Airborne: $6.88/letter → Price: $7.20

How? Contractors • 80% utilization • No ads • Lower overhead

But watch marginal costs… ⚠️

Question 4: Competitive Advantage 🏆

Sources of Airborne’s Advantage

Beyond Just Being Cheaper

Cost advantages 💰: Avoided fixed costs • Variable > Fixed • 80% utilization

Strategic advantages 🎯: Perfect customer fit • Competitor inflexibility • System coherence

Lower costs ARE the strategy - but only for THEIR customers

The catch? High marginal costs make them vulnerable ⚠️

The Achilles’ Heel ⚠️

Average vs Marginal Costs

Average Cost

Airborne wins by ~20%

  • Spread fixed costs better
  • Efficient operations

Marginal Cost

Airborne likely loses

  • Contractors cost more/package
  • Old planes less fuel efficient
  • Manual sorting labor-intensive

In a price war, Airborne dies!

Critical: Must keep FedEx/UPS uninterested in their segment 🛡️

Strategic Challenges Ahead 🎯

What Threats Does Airborne Face?

Now: Distance pricing • Giants eyeing their segment • Tech demands ↑

Future: Scale race continues • Need ground network? • RPS partnership?

💣 October 1997: FedEx buys RPS for $2.4B

Now what? 😰

Key Takeaways 📚

Lessons from Airborne Express

Strategic: Industry evolution creates niches • Focus enables survival • Low cost ≠ Safe

Analytical: Track industry dynamics • Map business models • Analyze costs (average + marginal)

Epilogue: DHL bought Airborne (2003) for $1.2B

Not bad for the little guy! 💪

For Monday 📚

Southwest Airlines in Baltimore

Consider: Another David vs Goliath story?

Key question: What happens when the focused player grows? 🤔